Common US Expat Tax Mistakes and How to Avoid Them

Written by: Josh Katz, CPA

Moving abroad can be an exciting adventure, offering new experiences and opportunities. However, amidst the excitement, American expats need to stay mindful of their tax obligations. Navigating international tax laws can be complex, and making mistakes can lead to financial penalties and stress. Below are some common US expat tax mistakes and guides on how to avoid them.

Mistake #1: Misunderstanding Tax Residency

Tax residency determines where you are required to pay taxes on your income and can vary depending on your circumstances and the tax laws of the United States and your country of residence.

Common Misconceptions:

  1. Automatic Non-Residency

    Some expats assume they are automatically exempt from US taxes once they leave the US. However, leaving the US does not necessarily mean you are no longer a US tax resident.

  2. Foreign Residence Equals Non-Residency

    Living abroad doesn’t automatically establish non-residency for tax purposes. Even if you spend most of your time abroad, factors like maintaining a US home or substantial business interests can impact your tax residency.

  3. Dual Residency Misunderstandings

    A dual residency situation occurs when you meet the tax residency rules of both the US and your host country. Some expats assume they have the discretion to select their preferred tax residency. However, tax treaties and specific tie-breaker rules help resolve dual residency scenarios.

To avoid misunderstanding tax residency, here are a few things you should consider:

  • Know the Substantial Presence Test: This test determines your US tax residency based on the number of days you were physically present in the US over three years. You are considered a US tax resident if you exceed a certain threshold.

  • Familiarize Yourself with the Bona Fide Residence Test: If you’re a bona fide resident of a foreign country for an uninterrupted period, you might qualify for the Foreign Earned Income Exclusion (FEIE), which allows you to exclude a certain amount of foreign-earned income from US taxation.

Mistake #2: Failing to File a Tax Return

Common Misconceptions:

Filing a tax return is a fundamental obligation for all US citizens and green card holders, regardless of where they reside. Failing to file a tax return can lead to financial and legal consequences, even for expats living abroad.

Table of Contents

  1. Exemption from US taxes

    Some expats mistakenly believe living outside the US exempts them from filing a US tax return. However, the US tax system is based on citizenship or green card status, meaning that US citizens and green card holders are subject to US taxation on their worldwide income, irrespective of their place of residence.

  2. Foreign Earned Income Exclusions as a Substitute

    The Foreign Earned Income Exclusion (FEIE) allows expats to exclude a certain amount of foreign-earned income from US taxation. While this can reduce or eliminate tax liability, it doesn’t eliminate the obligation to file a tax return.

  1. Misunderstanding Filing Thresholds

    Expats might assume they don’t need to file if their income is below a certain threshold. However, these thresholds can vary based on filing status and age.

To ensure that you are tax-compliant and avoid the negative consequences of failing to file a tax return, consider the following:  

  • Understand Your Filing Obligations: Familiarize yourself with the filing requirements for expats, including income thresholds, deadlines, and necessary forms. If you cannot prepare your own tax return, it is always advisable to consult a professional that provides tax services for Americans abroad to help with your tax filing obligations.
  • Utilize Available Exclusions and Credits: Expats can access various tax benefits, such as the Foreign Tax Credit (FTC) and the FEIE. Properly claiming these can reduce your tax liability.
  • Maintain Accurate Records: Keep meticulous records of all income earned and expenses incurred domestically and abroad. This documentation is essential for accurate tax reporting.

Mistake #3: Ignoring Foreign Financial Accounts

The US government requires citizens and residents to disclose their foreign financial accounts if the aggregate value of these accounts exceeds certain thresholds. The primary purpose of this reporting is to curb tax evasion and ensure transparency in international financial activities.

Common Misconceptions:

  1. Irrelevance of Foreign Accounts

    Some expats might assume that their foreign financial accounts are irrelevant to US tax obligations, especially if they no longer reside in the United States.

  1. Non-Taxable Income Means No Reporting

    The reporting requirement applies even if the income earned in foreign financial accounts is not taxable. Failure to report these accounts can result in penalties, regardless of the tax implications.

  1. Assumption of Privacy 

    The assumption that foreign financial institutions won’t share account information with US authorities is a misconception. Many countries have agreements in place to exchange financial information with the US through the Foreign Account Tax Compliance Act (FATCA).

To avoid the potential repercussions of ignoring foreign financial accounts, consider the following guidelines:

  • Understand Reporting Thresholds: Understand the reporting thresholds for different types of foreign financial accounts. These thresholds may vary depending on your filing status and location.
  • File the FBAR Form: File the Report of Foreign Bank and Financial Accounts (FBAR) form if the aggregate value of your foreign financial accounts exceeds the threshold (currently $10,000). This form is separate from your tax return and is due annually.
  • Include Relevant Forms: In addition to the FBAR, certain foreign financial assets may need to be reported on your tax return using Form 8938. 

Mistake #4: Failing to Report All Foreign Income

US citizens and permanent residents must report their worldwide income to the Internal Revenue Service (IRS). Any income earned abroad must be disclosed to determine the appropriate US tax liability.

Common Misconceptions:

  1. Exemption for Foreign Income
    Some expats mistakenly believe that income earned abroad is exempt from US taxation. While specific exclusions and credits might apply, reporting the income is still necessary.

  1. Local Tax Compliance Suffices
    Relying solely on local tax compliance in your host country does not relieve you of your obligation to report foreign income to the IRS.

  1. Overlooking Various Income Sources 
    Expats might unintentionally omit diverse income sources like rental income, self-employment earnings, dividends, or gains from the sale of foreign assets from their US tax return.
Universal Tax Professionals

Need help with your US expat taxes?

Understanding the diverse types of income that require reporting is crucial to ensure that you adhere to tax regulations and avoid the risks associated with not reporting foreign income. It is also important to properly categorize them as each type may have distinct reporting requirements and could impact your overall tax liability. 

Mistake #5: Not Taking Advantage of Tax Treaties

Tax treaties are bilateral agreements negotiated between countries to prevent double taxation, promote cooperation, and provide tax benefits to individuals and businesses operating across borders. These treaties often address various aspects of taxation, including income, estate, and gift taxes.

Common Misconceptions:

  1. Irrelevance to Expats

    Some expats might believe that tax treaties are primarily for multinational corporations or high-net-worth individuals, and therefore, they don’t apply to their individual circumstances.

  2. Limited Benefits

    Expats might assume that tax treaties only address income taxation, overlooking the potential advantages in areas like estate and gift taxes.

  3. Complexity of Understanding

    The complexity of tax treaties and the fear of misunderstanding their provisions might deter expats from exploring the benefits they offer.

To maximize tax treaty benefits and prevent missed opportunities, research your country’s treaty with the US, identify income tax, rates, and exemptions, and understand tie-breaker rules in cases of dual residency to determine your tax status and prevent double taxation. 

Mistake #6: Forgetting State Tax Obligations

While US federal tax obligations remain regardless of location, state tax requirements can vary based on your state residency. Some states impose income tax on residents, and the rules can be complex, mainly when living abroad.

State Taxes

Common Misconceptions:

  1. Tax Residency 

    Expats might assume that by moving abroad, they automatically cease to be residents of their former state. However, states often have specific criteria to determine residency for tax purposes.

  1. No State Income Tax While Abroad 

    Some expats believe they will only owe state income tax if they live in their home state, which is not true. Some states tax residents on their worldwide income.

  1. Importance of Domicile 

    Domicile, often established by intent, is crucial in determining state residency and tax obligations. Neglecting to address domicile changes can lead to continued tax liabilities in the previous state.

To avoid unexpected state taxes, ensure you know the tax rules in the state where you used to live and where you now live. This includes understanding who needs to pay taxes, how much you might have to pay, and when to submit tax forms. Be aware that each state has a unique tax burden, which can significantly impact your financial obligations. If you’re moving to a new country, show that you plan to live there to avoid taxes in your old state. 

Mistake #7: Not Seeking Professional Guidance

International taxation is known for its intricacies, including tax residency rules, foreign income reporting, tax treaties, and tax credits. Attempting to decipher these complexities without specialized knowledge can lead to misunderstandings and errors.

Common Misconceptions:

  1. Sole Reliance on Online Resources 

    Relying solely on Internet research or general tax information might lead to overlooking crucial details concerning your unique situation.

  1. One-Size-Fits-All Approach 

    Assuming that tax advice that works for one expat will work for everyone can be misleading, as individual circumstances vary greatly.

  1. Cost vs. Benefit 

    Some expats might think professional guidance is expensive, and they can handle their tax matters independently to save money.

There are several important factors to consider when seeking a tax professional:

  • Expertise and Specialization: Look for tax professionals specializing in expatriate taxation and understanding international tax laws. in  Their expertise will ensure accurate and efficient handling of your unique tax situation.
  • Credentials: Ensure that the tax professional holds relevant credentials, such as Certified Public Accountant (CPA) or Enrolled Agent (EA) qualifications, indicating their expertise and adherence to professional standards.
  • Experience: Choose a professional with a proven track record of assisting expatriates. Experience handling cases like yours will increase the likelihood of receiving accurate advice.
  • Reputation: Research the tax firm’s client reviews, testimonials, and references to gauge the quality of their US expat tax services. Personal recommendations from other expatriates can be particularly valuable.
  • Fees: Understand the fee structure upfront. Some professionals charge hourly rates, while others offer fixed fees for specific services. Clarify what services are included in the prices and any potential additional charges.

Getting help from a tax professional for your US taxes has multiple advantages. These experts know complex tax laws, especially for expats, ensuring accurate filings. They find deductions, credits, and exemptions to lower your tax. Professionals reduce the risk of errors and penalties and save you time managing paperwork and giving personalized tax advice. With year-round support, they provide a comprehensive approach to tax management, guiding you through cross-border complexities and maintaining your information’s confidentiality and security.